Market Signals A Bottom: Time To Own Stocks

by: John Tobey, CFA

The headlines would have us believe the stock market plummeted – again. The explanation is that everything is going wrong, capped by those frightening words: “Global Recession.”

However, last week’s stock market message isn’t what it did, it’s what it didn’t do.

There was no drop

The stock market’s real decline was a short affair in early August. On Tuesday, August 2, the Dow Jones Industrial Average (DJIA) fell below 12,000, breaking its even-numbered resistance level. Five trading sessions later (on Tuesday, August 9), it touched a low of about 10,600. Its low closing level was 10,720 on the next day, August 10.

Since then, the stock market has certainly moved – a total of 5,000 points! But look where it just closed on Friday, September 23: At 10,771 – up 51 points from that August 10 close.

So, why didn’t the market go down and set new lows?

It’s not for lack of negative news, and it’s not because only the “insiders” are aware of what could go wrong. Everyone is talking about the bad stuff. And that’s why the market is likely at its bottom. The old saw, “Buy [or sell] the rumor; sell [or buy] the news,” seems to be at work once again.

But economists are predicting significantly lowered growth

Economist predictions generally are worthless for investment success (except for making contrarian investments against a popular consensus). Remember, these are the same people who predicted over 4% growth just a few months ago. So, they were wrong then but their under 2% forecasts are right now?

For investing, we need to focus on analysts. My recent article provides their perspective, and it shows the stock market has fallen to an especially attractive valuation level – one capable to generating a 20% to 30% return. This fact is why I believe the market is not falling further – prices are too desirable.

Now bring in the technicians

While referred to as tealeaf readers, technicians often use charts to evaluate investor behavior. As we know, emotions can play a large role in stock investing, so fundamentalists also keep a weather eye on actual stock price behavior.

I previously wrote about the appearance of a developing market foundation – a double bottom. With this last week’s drop, it’s time to reexamine that work.

Triple bottom picture emerges

The general market looks to be making a triple bottom, a potent sign not only for technicians, but also for fundamentalists. To the latter group, it is proof that the valuations are indeed desirable and that savvy investors are accumulating positions. Here is the picture for the three major indexes.

The DJIA exhibits a triple bottom...

click to enlarge
DJIA graph
(Charts courtesy of

As does the S&P 500...
S&P 500 graph
However, the Nasdaq appears to be moving up from its double bottom...
Nasdaq graph

The bottom line

The early August stock market drop anticipated the negative news we subsequently have seen. Since then, the market has been volatile, reflecting large trading activity, but has not fallen further. Rather it looks to have established a range based on fundamentals.

With this quarter ending Friday and the 3rd quarter earnings report season at hand, the stock market could easily shake off economists and mega-fears, refocusing on analysts and company prospects.

Therefore, now is an opportunistic time to own stocks.

What could go wrong?

At this point, with valuations so attractive, I believe the only way for the market to fall further is to have a technical breakdown, with the DJIA falling below 10,600. There is a great deal of trading activity in the market (as evidenced by the market moving 5,000 points to gain 51). These traders can easily shift to short selling and, without the uptick rule, could drive the market and emotions down.

However, such a move is profitable to traders only if it causes others to sell, lowering prices further. Weeks of U.S. stock mutual fund selling indicate that much individual investor selling already has been done. Therefore, any trader-inspired drop likely would be short-lived. At the first sign of market stability, short covering could ignite a sharp "V" shaped reversal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Positions: U.S. stocks and U.S. stock funds